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UPDATE 3-U.S. SEC charges Morgan Keegan with fraud

* Regulators say firm inflated value of subprime mortgages

* More than $1 billion investor losses alleged

* Morgan Keegan to fight “meritless” SEC, FINRA charges

* Shares of Morgan Keegan parent Regions Financial fall (Adds comment, state regulatory action, more FINRA details)

By Helen Kearney and Jonathan Stempel

NEW YORK, April 7 (Reuters) - U.S. regulators charged Morgan Keegan & Co and two employees with fraud for inflating the value of subprime mortgages and other risky debt in mutual funds, resulting in more than $1 billion of investor losses.

The charges -- announced Wednesday by the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority and a group of state securities regulators -- are the latest in a still small number of enforcement actions arising out of the nation’s housing and credit crises.

Morgan Keegan, a unit of Regions Financial Corp RF.N, said it plans to defend against what it called "meritless" charges.

Several Morgan Keegan funds, including some marketed as conservative investments for older investors, lost more than 50 percent of their value in 2007.

“The scheme had two architects: a portfolio manager responsible for lies to investors about the true values of the assets in the funds, and a head of fund accounting who turned a blind eye to the fund’s bogus valuation process,” said Robert Khuzami, head of the SEC enforcement division, in a statement.

In its complaint, the SEC said that Morgan Keegan fraudulently hid the falling value of some mutual funds between January and July of 2007, and “recklessly” sold fund shares to investors based on inflated prices.

The SEC accused portfolio manager James Kelsoe, 46, of improperly directing his accounting department to make repeated, arbitrary “price adjustments” that boosted the fair values of securities.

It also said Joseph Thompson Weller, 44, who led that department, failed to ensure the securities and mutual funds were properly priced.


According to Morningstar Inc, Morgan Keegan’s Select Intermediate Bond A fund fell 50.3 percent in 2007, while the riskier Select High Income A fell tumbled 59.7 percent.

It is rare for any kind of bond mutual fund to suffer annual losses of that magnitude, and Morgan Keegan has faced a slew of arbitration proceedings over its funds.

FINRA said it filed its own complaint, accusing Morgan Keegan of misleading investors about the funds’ safety, given their undisclosed exposures to mortgage- and asset-backed debt, and risky “structured products.”

Alabama, Kentucky, Mississippi and South Carolina, meanwhile, brought separate administrative proceedings.

Kurt Brouwer, a mutual fund expert and principal at Brouwer & Janachowski LLC in Tiburon, California, said other companies whose funds lost value in the housing and credit crises might also face liability for not properly disclosing risks.

“If they hold complex investments and the investments come from Wall Street, they have to make it clear to investors that these things can blow up,” he said, “because the market for the securities is not established.”


Eric Bran, a spokesman for Morgan Keegan, called Wednesday’s charges “meritless and based upon erroneous hindsight analysis. We will vigorously refute these charges.”

A lawyer representing Kelsoe and Weller did not immediately return a request for comment.

The SEC plans to seek a hearing before an administrative law judge to determine sanctions, including possible fines.

FINRA wants Morgan Keegan to give up ill-gotten profits and make full restitution to investors.

Hyperion Brookfield Asset Management Inc took over management of some Morgan Keegan funds in 2008.

Morgan Keegan is based in Memphis, Tennessee. Regions is a large Southeast regional bank based in Birmingham, Alabama.

In afternoon trading, Regions shares were down 4 cents at $8.51 on the New York Stock Exchange. (Reporting by Helen Kearney & Jonathan Stempel; Additional reporting by Diane Bartz in Washington, D.C.; editing by Tim Dobbyn, Matthew Lewis and Steve Orlofsky)